Can We Allow Self-Interest to Rule Markets?

The 8 December, 2009 interview by Kai Ryssdal of Nancy Koehn of the Harvard Business School ended with the following:

RYSSDAL: So when we look back on this period, on 2008-2009, what lessons will we have learned? Will we have learned anything do you think?
KOEHN: I think we’ll have learned several things. One, that we are incredibly tightly connected. We really are a global village in a way we’ve never been. Second, I think we’ll learn that we overlook history, and its lessons at our own peril. And I think we’re going to have to learn that Adam Smith’s invisible hand of self-interest is really no longer a useful descriptive of the way that market capitalism in the 21st century works. We simply cannot pursue a marketplace that is motivated and fueled by individuals pursuing their isolated self-interest.

As the founder of a company named Adam Smith Consulting, and the author of a book about innovation that I am currently writing called, “The Invisible Hand,” I put considerable thought into Nancy Koehn’s assertion that Adam Smith’s ideas may not be as valid today as they were in 1776.

Adam Smith’s book, “An Inquiry Into the Wealth of Nations” was first published in London in 1776. Smith was concerned that politicians in his time were protecting industries and “favored” businesses and the result would be that England’s national strength would be diminished by industries that would be weaker than foreign competitors. Eighty-Three years before Darwin, Adam Smith had a notion of natural order, and the strength derived from the healthiest domestic businesses prevailing in an open market. He said,

To give the monopoly of the home market to the produce of domestic industry, in any particular art or manufacture, is in some measure to direct private people in what manner they ought to employ their capitals, and must in almost all cases be either a useless or a hurtful regulation. If the produce of domestic can be brought there as cheap as that of foreign industry, the regulation is evidently useless. If it cannot, it must generally be hurtful. It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy.
- Adam Smith, 1776, “An Inquiry into the Nature and Causes of the Wealth of Nations”, Book 4, Chapter 2

What Adam Smith did say about individual self-interest and the, “Invisible Hand” was,

He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain; and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest, he frequently promotes that of the society more effectually than when he really intends to promote it.
- Adam Smith, 1776, “An Inquiry into the Nature and Causes of the Wealth of Nations”, Book 4, Chapter 2

Smith believed that in a free-market, individual business leaders in pursuit of their own self-interest would continually improve their business processes, the training and skill of their workers, and the use of technology to decrease labor. Adam Smith deduced from his now famous analysis of British Pin Manufacturers (the scene depicted on the front of the UK 20 pound note) that the most successful businesses were focused on continually improving (e.g. transformation).

My personal and corporate allegiance to Adam Smith is that a focus on transformation and continuous improvement will lead to strong and vibrant businesses that do lead to a better society. Smith said,

Men are much more likely to discover easier and readier methods of attaining any object, when the whole attention of their minds is directed towards that single object, than when it is dissipated among a great variety of things.
- Adam Smith, 1776, “An Inquiry into the Nature and Causes of the Wealth of Nations”, Book 1, Chapter 1

I would answer Kai Ryssdal’s original question a little differently, “So when we look back on this period, on 2008-2009, what lessons will we have learned?” Adam Smith said that individual self-interest would lead like an “Invisible Hand” to a healthy nation and society. Contrary to popular belief Adam Smith also believed in a balance of regulation and freedom-of-choice not a blind notion of unregulated free-markets. When Adam Smith raised the concept of self-interest driven economies in 1776 he was trying to raise the awareness about the power of freedom-of-choice versus traditional royal and political decree. I believe trying to align Adam Smith to Gordon Gecko proclaiming in the movie Wall Street, “Greed is Good,” is a mistake. The 2008-2009 economic crisis is the result of the visible hand of government. Our politicians were lobbied into economic policy that: unnaturally deregulated the financial institutions encouraging bad behavior, tightened immigration policy that encouraged offshore outsourcing, and diminished incentives to invest in domestic industry while increasing visibility on quarterly profits. We need to rebalance our economy by reversing these political influences, and once again our economy will naturally be led by a focus on innovation and improvement that drove the industrial and technological revolution of the last two centuries.

Ed Fullman, Partner, Adam Smith Consulting
www.adamsmithconsulting.com